Reason Magazine - Staff

Covert Advertising

info@reason.com (John Hood) — Wed, 01 Mar 2006 00:00:00 EST

When Peter Parker shot out his webbing and snagged that can of Dr. Pepper in Spider-Man, it seems that impressionable movie audiences across the country suffered deleterious consequences--perhaps in the form of forgetting how much they loved Mr. Pibb. "The public needs to know when they're being advertised to," says Jonathan Adelstein, one of the five appointees who run the Federal Communications Commission. To that end, he wants his agency to require a lengthy disclosure notice during every TV show with paid placements, an effort he believes it can justify with the laws governing payola.

Product placement isn't a new problem. Indeed, it isn't even a problem. In the golden age of radio, the republic survived product placement during soap operas and The Jack Benny Program without suffering an epidemic of obesity. (Remember "There's always room for Jell-O"?) Consumers may well prefer brand placements over watching endless blocks of commercials, but they'll rebel if the insertions become too distracting. Smart advertisers don't want to drive their audiences to the next channel.

But even if product placement were a crisis demanding government intervention, Adelstein's proposal to require lengthy, prominent disclosures would be a peculiar solution. Audiences will ignore the disclosures the same way they're increasingly ignoring (or TiVoing past) commercials--the same behavior pattern that's driving the move toward product placement in the first place. If only there were a way the FCC could place its message somewhere in the show itself...�

Warning: Coke, Though Refreshing, Is A Sponsor of This Program

info@reason.com (John Hood) — Tue, 22 Nov 2005 00:00:00 EST

Not content to save us from global warming, catastrophic cooling (said to result from global warming; don't ask), poisonous food, unsafe workplaces, dangerous water sports, and lawn darts, the federal regulatory apparatus in Washington now has a bright, shiny new cause: It wants to save us from product placement.

When Peter Parker shot out his webbing and snagged that can of Dr. Pepper a few years ago in Spider-Man, it seems that impressionable movie audiences across the country suffered deleterious consequences—perhaps in the form of forgetting how much they loved Mr. Pibb. Jonathan Adelstein, a member of the Federal Communications Commission, is particularly outraged at what he sees as product-placement manipulations by TV networks. Because "the public needs to know when they're being advertised to," Adelstein told The Wall Street Journal, he wants the FCC to investigate the practice and require a lengthy, large-font disclosure notice during every TV show with paid placements.

Other policymakers and observers have been hyperventilating about the proliferation of product placement since February, when the Federal Trade Commission declined to require disclosure of product placement as a remedy for what activist groups such as the Naderite Consumer Alert consider fraudulent trade practices. "The FTC has essentially endorsed the deceptive and dishonest practices of the product placement industry," said Consumer Alert executive director Gary Ruskin, "and turned its back on children who are suffering from an epidemic of marketing-related diseases like obesity and type 2 diabetes." Paid placements in TV shows, movies, and other entertainment aren't just intrusive and manipulative, say these scolds, but cost taxpayers billions of dollars a year by jacking up Medicare and Medicaid costs as mesmerized consumers smoke, drink, and get fat.

The FCC's Adelstein argues that his commission and the FTC have different purposes and burdens, so the FCC has "no choice but to enforce" existing law against advertising payola. But if product placement is a new problem—and it is neither new nor a problem—then his proposal to require lengthy, prominent disclosures is an outmoded way of dealing with it. Audiences will ignore the disclosures the same way they're increasingly ignoring (or TiVoing past) commercials—the same behavior pattern that's driving the move toward product placement in the first place.

There is no question that product placement is a rapidly growing element in the marketing mix. According to surveys by PQ Media, companies will spend about $4 billion in 2005 to place products in various media, roughly double what they spent in 2001. The consumer conglomerate Procter & Gamble, traditionally one of the biggest buyers of TV commercials for products such as Tide and Pampers, just announced that it is cutting its purchase of ad time this year by 5 percent on broadcast networks and by a whopping 25 percent on some cable channels. Some of these dollars are shifting to product placement. But contrary to the rhetorical assertions of self-styled consumer advocates and their political patrons, this is not uncharted territory. In a sense, marketing professionals are going back to the future by making use of a technique that has been around about as long as advertising itself.

In ancient Rome, major winemaking regions apparently compensated poets such as Martial and Horace to work brand names into their writing. Advertorials arose shortly after general-circulation newspapers and magazines did. And by today's standards, the product-placement deals during the Golden Age of radio would be seen as thoroughly shameless.

One of the first successful "soap operas" was CBS' Today's Children. While it did begin its run with two General Mills soap brands as its sponsors, the program quickly became a key marketing vehicle for Pillsbury, whose sponsorship was certainly not limited to formal ad spots. The central character of Today's Children was Mother Moran, the matron of an Irish-American clan who spent much of her airtime in the family kitchen. Producers made cake-baking a frequent plot device, as were kitchen-table conservations about the latest innovations from Pillsbury. In one story, Moran wrote to a "Mrs. Pillsbury" for help with kitchen aids and was later treated to a tour of Pillsbury's Minneapolis facilities. In another, her granddaughter Lucy used Pillsbury brand names in writing a paper for school entitled "The Story of Bread." On a rival show sponsored by General Mills, the company's trademarked character Betty Crocker made guest appearances to promote bread-making.

Radio listeners during the 1930s and 1940s saw explicit placement of companies and products into their radio shows as anything but an intrusion. According to surveys conducted at the time, they preferred product placement to clearly distinguished advertising spots because the latter took "time away from the story." Product placements also were seen as a way to make programs more accessible to ordinary people by bridging the gap between reality and fantasy.

That didn't make the audiences mere zombies, ready and waiting to buy whatever they saw or heard about. Just as product placement isn't new, neither is knowing banter about the practice by performers well aware of consumer skepticism. There's a great scene in Wayne's World where Wayne and Garth, winking at the camera, repeat a string of ad slogans. It's even funnier when you appreciate it as a gesture to past comics and movies that did the same thing. For example, Jell-O was a longtime sponsor of Jack Benny's radio show. The program began and ended with a straightforward promotional message for Jell-O by the announcer, Don Wilson. But the middle "commercial" consisted of Wilson working his way into whatever comedy routine was underway and, not very gracefully, slipping in a mention of Jell-O. Benny and the other cast members would then typically offer up some good-natured jokes at Jell-O's expense before continuing the show. They were entertaining and advertising at the same time.

The Republic survived product placement during radio soap operas and The Jack Benny Program without an epidemic of obesity. (Remember "there's always room for Jell-O"? How irresponsible!) Consumers aren't idiots. They may well prefer brand placements during their favorite TV shows to watching seemingly endless blocks of commercials, but they'll rebel if the placements become too distracting. "We must embrace the consumer's point of view about TV and create advertising consumers choose to watch," said Jim Stengel, a Proctor & Gamble marketing officer, when asked to explain the company's shift of strategy.

That's exactly right: In a free market, companies must act over time in the way most likely to maximize their profits, which tends to discipline them against harming or annoying their own consumers. Unfortunately "consumerists" who thrive on litigation and politics face very different incentives.

John Hood is president of the John Locke Foundation in Raleigh, NC, and the author of Selling the Dream: Why Advertising is Good Business, just out from Praeger.

Racial Blind Spots

info@reason.com (John Hood) — Sat, 01 Oct 2005 00:00:00 EDT

Myths of the Republican Mullah-cracy

info@reason.com (John Hood) — Mon, 08 Nov 2004 00:00:00 EST

It took only a few hours for media talking heads to come up with an explanation for why the tax-cutting, war-mongering ignoramus George W. Bush got re-elected on Tuesday. It couldn't have been, they agreed, that the electorate truly wanted four more years of Republican domestic and foreign policies. After all, didn't John Kerry win every substantive point on the issues that really matter? Wasn't Bush an accidental, illegitimate president in the first place? Another explanation had to be found.

Quickly scanning the exit polling, pundits spotted that 22 percent of voters had said "moral issues" were the most important in the race, and they broke heavily for Bush. A-ha! Now they had a talking point: evil mastermind Karl Rove had used the same-sex marriage issue to turn out so many religious conservatives that they overwhelmed everyone's likely-voter models and became a disproportionate share of the 2004 electorate.

The initially unspoken, but soon loudly proclaimed, implication of this fact was that Bush and the Republicans had bamboozled these voters, whose real economic interests lay with the Democrats. They didn't truly support Bush on substantive domestic and foreign-policy issues. They were just anti-gay bigots. As the spin got more frenzied Wednesday and Thursday, words like "jihadis" and "mullahs" got attached to these deluded and dangerous Bush voters, whom Democrats and sympathetic analysts described as something akin to a bizarre and perversely fascinating lost tribe just discovered in the rain forests of Borneo. By weekend, an inevitable backlash against the frenzy had set in.

The problem with all this is that, while comforting to many Kerry supporters and exhilarating for some social-conservative leaders, the notion that Bush won primarily because religious voters turned out for him does not seem to be backed up by any real evidence. Few reporters or commentators appear to have gone back to examine the 2000 exit polls, which would seem to be necessary if one wishes to assert a trend.

I did. I found that the percentage of voters sampled who said they attended church at least weekly was the same—42 percent—in both 2000 and 2004. The percentage never attending church was also the same, at 15 percent. The middle group, those attending occasionally, was, you guessed it, 42 percent each time. Interestingly, while Bush slightly improved his standing among frequent churchgoers, by about a point in 2004, his support grew by 3 to 4 points among those attending seldom or never.

Yep, it was the atheist vote that really put Bush over the top in 2004.

There could be other ways to salvage the myth of the Republican mullah-cracy. For example, one might argue that it is unfair to equate church-going with religiosity or cultural conservatism.

Another potential proof: More people identified themselves as conservatives in 2004 (34 percent) than in 2000 (29 percent). But there are all kinds of conservatives, including quite a few who are socially conservative and hawkish and in favor of privatizing Social Security. Sorry, this doesn't prove anything other than people are increasingly willing to label themselves as conservative rather than moderate.

OK, what about issue positions? In 2000, about 40 percent of voters in the exit poll said that abortion should be mostly or always illegal. In 2004, it was 42 percent. Not exactly a huge jump. And we don't know how many of those are single-issue voters on abortion. Both parties have significant minorities who disagree with the official party position: about a quarter of pro-lifers voted for Kerry, while around one-third of pro-choicers picked Bush. On same-sex marriage, the issue was not polled in 2000 so it is impossible to say with certainty how the two electorates compare, but it is unlikely that this year's voters were significantly more conservative on it. In fact, the public's position is more nuanced here than the insta-spin would have you believe. About as many favored civil unions but not official marriage (35 percent) as favored neither (37 percent), and Bush was preferred by both groups over Kerry.

Well, perhaps there was no national trend but it happened in selected states such as Ohio. Nope. In the 2000 exit poll for Ohio, the percentage of frequent churchgoers was higher (45 percent) than in 2004 (40 percent). Bush did win a larger majority of religious Ohio voters in 2004 than he did four years ago, but there were fewer of them proportionally. Besides, saying that the religious-vote affect mattered in a few key states changes the nature of the media spin, which has been trying to assert it as a sweeping national "explanation" for Bush's popular vote.

That leaves the initial assertion about 22 percent of voters citing moral issues as most important, higher than the share citing terrorism, Iraq, the economy, or other issues. When I looked more closely at this question, however, doubts immediately presented themselves. For one thing, the answers were broken out in ways that biased the analysis. While the poll did not attempt to distinguish the various moral issues that voters might be thinking about—abortion, marriage, wars for oil, etc.—it did list "taxes" and "the economy" separately, as well as "terrorism" and "Iraq." Of course, for many voters, these are not separate issues. You may disagree with them, but most voters sampled in the exit poll said that the war in Iraq was part of the overall war on terrorism. And many right-leaning voters see tax policy as inextricably linked with economic growth and job creation (at least a few freedom-loving folks even see tax cuts as a moral issue—imagine that!)

In short, the question is flawed and the answers easily misunderstood. Moreover, it doesn't compare well with the 2000 exit poll, in which "moral issues" was not listed as an option. On the other hand, you can track the impact of foreign policy over time. In 2000, only 12 percent said that "foreign affairs" was the most important issue in the presidential race, and they broke 54 percent to 40 percent for Bush over Gore. In 2004, a combined 34 percent identified foreign policy (either Iraq or the war on terrorism) as the most important, and they appear to have broken for Bush by 59 percent to 40 percent. Put it all together, and the increase in salience and small increase in Bush preference for foreign policy constitutes a gain of 13.5 percentage points in the Bush vote in 2004.

Obviously, he didn't win by that much. He lost ground on economic issues, because of the recession. But without his edge on war on terrorism, Bush would have lost. And that proposition—unlike the "it's all about gay marriage meme"—is testable and fits the available data. Voters worried about partial-birth abortion, same-sex marriage, and other cultural issues are obviously an important constituency within the current GOP majority, but they are no more responsible for Bush's national victory on Tuesday than voters motivated by other issues to re-elect the president.

Bush's Missed Opportunity

info@reason.com (John Hood) — Wed, 21 Jan 2004 00:00:00 EST

President George W. Bush blew it Tuesday night. He delivered a State of the Union address that downplayed his most promising—and potentially revolutionary—domestic-policy initiatives. Earlier drafts had reportedly contained a lengthy exposition of his vision of an "ownership society," expanded and strengthened by tax changes and Social Security reform. Unfortunately, by the time Bush gave the address, his ideas were dispersed throughout a laundry list of issues, and his Social Security proposal was granted only a brief and halting mention. He spent more time talking about new federal subsidies for community college training. From a public-policy perspective the decision was disappointing; it may also prove to be politically costly.

Many Republican politicians believe that President Bush, who in some polls has the highest approval rating of any president beginning his re-election campaign since Dwight D. Eisenhower in 1956, is headed for an inevitable victory in November. With Saddam Hussein in custody, a resurgent economy, and a muddled and perhaps longer-than-expected Democratic primary, these partisans see little on the horizon to threaten the president's political prospects. They wonder only how big his margins will be, and whether they will translate into coattails in key GOP races for Senate, House, governor, and state legislatures.

This is a premature conclusion, to put it gingerly. While the sputtering, gesticulating implosion of Howard Dean and the available survey data may suggest that the Iraq campaign has subsided as a potential campaign issue, it wouldn't take much for a series of adverse events—a major terrorist incident overseas, another round of deadly attacks by insurgents in Iraq, or disclosures about intelligence failures—to change the political dynamic. Besides, given that about two-thirds of the electorate favored the war and a similar number prefer the Republican Party on issues of national defense, the Bush team probably wanted the 2004 election to present a clear divide between the president and a starkly anti-war candidate such as Dean. Now that the Iowa results have shuffled the Democratic deck, it may turn out that Bush will face a general-election foe such as John Kerry or John Edwards who voted for the war resolution but disagreed about how the policy was then carried out—a message that would muddy the very waters Karl Rove and company would prefer to keep crystal clear.

The Democratic nominee may well choose to challenge Bush on domestic issues while seeking only to neutralize the GOP advantage on foreign policy. It's worked before. That's precisely what then-Arkansas Gov. Bill Clinton did in 1992 to President Bush's father, who if anything enjoyed greater public confidence in his national-security and foreign-policy credentials but found he couldn't rely on this advantage alone to win. Even in this post-9/11 environment, domestic issues are still more important to most voters, hard as it may be for both confident hawks and embittered doves to believe. In a recent TechnoMetrica poll for Investor's Business Daily, respondents rated health care far more important an issue (with an index rating of 44.1) than was the war in Iraq (26.5). This was true both for war supporters and for war opponents.

The problem for Bush and the Republicans is that if the security issue gets muted during the 2004 campaign, a good chunk of their political base will get uncomfortable. It is difficult to overstate the extent to which the limited-government, free-market faction of their coalition—including mainstream Reagan Republicans, old-style balanced-budget moderates, and small-l libertarians—have been dismayed by Bush's dismal record on federal spending and entitlements. Non-defense discretionary spending under Bush and a Republican Congress soared by nearly 19 percent in two years, a rate not seen in decades and one making Bill Clinton look like Calvin Coolidge.

The fallout is visible. Both sitting conservative members of Congress and candidates I've talked to in North Carolina, for example, freely express their disappointment in private and often in public forums. Radio talk shows, web sites, and other institutions that serve to channel activist energy at the grassroots exhibit significant disaffection. Even such Washington-establishment groups as the Heritage Foundation haven't shied away from savaging the president and the GOP with surprisingly blunt language. "The Republican party is simply not interested in small government now," says Brian Riedl, a Heritage Foundation budget analyst who has been particularly caustic. "They're worse than the Democrats they replaced."

Some Bush supporters clearly aren't worried about this furor on the Right. After all, where do fiscal conservatives have to go, exactly? To a Democrat promising expensive new health care and education initiatives of his own, as well as at least a partial reversal of the Bush tax cuts? Besides, wasn't it enough for Bush and the Republican Congress to pass those three tax cuts in three years, slashing marginal rates and reducing the double-taxation of dividends and capital gains?

These questions demonstrate a fundamental misunderstanding of Republican-leaning fiscal conservatives, what motivates them, and why they choose to be involved in the political process at all. The Democratic coalition is a motley collection of groups bound together primarily by the prospect of getting things from the government, be they public assistance, Social Security and Medicare, free health care and education for their children, corporate welfare, quotas, protectionist regulations, or symbolic affirmation. Most of them are pragmatic about this. They know they may not get a goodie this year, but they expect to get a turn in the next. When government finances tighten, they somewhat adjust their expectations of booty. When growth fills the coffers, they bargain for a bigger payday.

Many voters in the Republican coalition exhibit some of these traits, but they are more conflicted about what they want from the government. Purists simply want to be left alone, as activist Grover Norquist would say. But many less ideological Republicans experience a cognitive dissonance: they want freer markets and smaller government in the abstract, but also a perk or two if possible. For all of these Republican-leaning voters, though, including the hypocrites, a political message of "just wait by the trough and you'll get yours directly" will never serve to inspire an effective effort to win a competitive campaign. Nor does a set of tax cuts, some consistent with sound principles but others little more than welfarism via long-form, automatically excuse profligate spending in their eyes. Republicans want to see how their leaders' fiscal policies tie into a coherent and compelling whole. Indelibly marked by the Reagan era, they want their candidates to articulate a basically restrained vision of government, of maximizing freedom and minimizing bureaucratic constraints. President Bush has actually exhibited flashes of rhetorical brilliance in this area, but this has made his unwillingness to set priorities or threaten budget vetoes all the more dispiriting for many fiscal conservatives with raised expectations.

And it is a huge mistake to think that there's nothing they can do about it. They have options. One is simply to stay home. If Karl Rove thinks it was rough for George W. Bush to have to eke out a slight Electoral College majority in 2000 because millions of social conservatives stayed home, he should consider how much less fun it was for George H.W. Bush to run for re-election in 1992 without a strong turnout by the anti-tax conservatives he had spurned. Another option is the Naderite one, that of voting for third-party candidates. While I don't think there are enough libertarian-leaning Republicans willing to vote Libertarian to turn the presidential election—though it's not inconceivable if a 2000-style photo finish recurs—the story is much different at the state level, where I think it is demonstrable that some close elections for Congress or legislature have been lost by Republican candidates because of defections to LP challengers.

It's not as though the Bush administration had to take on every unconstitutional federal program and close down every redundant federal agency or department in order to satisfy its base. Many of these voters understand that eliminating the Department of Education tomorrow isn't a politically salable notion. Americans as a whole are even more conflicted than the core Republican coalition, far less convinced that the size and scope of the federal government needs to undergo dramatic transformation. But the latter want to see some significant efforts in the right direction—at least a firm commitment not to start any new, likely-to-burgeon programs and a willingness to negotiate aggressively with pork-crazy lawmakers. To promise, as President Bush did in his address, to hold discretionary spending increases to "only" four percent is not to supply this thematic glue to hold the political coalition together. Indeed, the one time I heard Bush mention the word "veto" he did it in the context of Medicare—promising, yes, that he would block any attempt to strip the (limited) consumer-choice provisions from the law but also promising to veto any diminution of the new and highly expensive prescription-drug benefit.

There was a way for Bush to offer a more inspiring message, one calculated to ease the frustrations of fiscal conservatives and giving them the sense that any compromises on spending and entitlements in the short run would result in smaller government in the long run. That's why early reports about President Bush's State of the Union speech were so intriguing. They suggested that he might tie together his advocacy of expanded IRAs, savings-based health reform, and personal Social Security accounts to articulate a rhetorical vision of an ownership society to replace the current syndrome of dependency on government to finance the big-ticket items of life: buying a home, educating children, suffering a major illness or disability, losing a job, and retiring.

In my 2001 book Investor Politics, I wrote that conservatives and libertarians had failed to make any real headway in their fight against big government in Washington because they had wrongly seen it as an open-field battle with a willing adversary. They tended to charge, lances couched, banners flying, right into a stone wall—because the welfare state isn't an opposing army. It is a fortress. It is surrounded by high walls, deep moats, and angular bastions. It cannot be taken by a frontal attack. But perhaps it can be undermined, in the original sense of the term of creating breaches in the walls by digging underneath and using fire to collapse the tunnel. Converting transfer programs into savings accounts, even accounts sheltered or somewhat subsidized by government, would offer individuals the opportunity to take responsibility, to manage money, to shop wisely, to choose private providers of services, to plan for their future needs, and to escape the control of planners and bureaucrats. Just as homeownership tends to change the way voters behave in local elections, so the theory goes, a broader ownership of financial assets would expand the national constituency for lower taxes, less government, more freedom.

There is some evidence supporting this theory in polling and in some recent campaigns where Republican candidates advocating Social Security accounts won sizable majorities of the vote. But I admit that it is ultimately speculation. It's still worth exploring further because previous, more direct assaults on big government have failed miserably and because the retirement of the Baby Boom generation starting in the next decade will put unprecedented pressure on the federal budget, pressure that may lead to massive tax increases. President Bush has commendably kept his Social Security proposal alive despite the grave concerns expressed by Republican political "pros" about venturing out on that big, drooping limb and once again inviting Democrats to break out their saws. Apparently their advice won out this time. I see the problem differently. If Bush never dares anything big in domestic policy, if he never gives anti-tax, small-government Republicans a reason to be excited and active, if he stays clinging to the trunk of the tree, the Democrats will still have something to saw—but the president won't be able to reach another perch.

Why the States Are Broke

info@reason.com (John Hood) — Wed, 01 Oct 2003 00:00:00 EDT

"For the first time in a long time, someone is going to be minding the store," declared the newly elected governor of a large Midwestern state. The occasion was an April speech defending his proposed budget and restating his campaign promise not to raise taxes. In response, the opposition leader in the state Senate repeated his call for major tax increases to close a yawning budget gap. Among other things, the senator wants to expand the state's sales tax to cover services. "There will be no haircut tax under this administration," the governor's deputy replied testily.

Meanwhile, in a nearby state, another governor was calling for a $2 billion sales tax expansion. His plan would tax services ranging from lobbying to dry cleaning, on top of already enacted increases in excise taxes on cigarettes and gasoline.

The no-new-tax governor was Illinois' Rod Blagojevich -- a Democrat. His legislative antagonist was Pate Philips -- a Republican. And his tax-increasing neighbor was Republican Gov. Bob Taft of Ohio.

Democrats as fiscal conservatives? Republicans as tax hikers? Welcome to the topsy-turvy world of government finance, where political labels can confuse more than inform, where experts specialize in deliberately misleading "analysis," and where all is not as it seems.

Since the onset of recession in 2001, the national economic debate has centered around President George W. Bush's proposed tax cuts, his terror-induced wave of new federal spending, and Capitol Hill squabbles about budget deficits and interest rates. For most Americans, however, these issues are distant, theoretical, and mostly rhetorical. More important are the images they're seeing on breathless local television newscasts and morning chat programs. In Kentucky they've seen convicts released early from crowded prisons. In California they've heard of possible mass layoffs of schoolteachers, following on the heels of a two-week stint of work without pay for Oregon teachers and new janitorial duties for their counterparts in Oklahoma. In Missouri state employees were unscrewing every third light bulb to cut energy bills.

Such images might help explain why polls show so little enthusiasm for the president's proposed tax cuts. Americans already have seen federal tax relief offset by tax increases at the state and local levels, with more hikes expected soon. And they're spooked by the apparent incompetence and penury of the governments that patrol their streets, pave their highways, and educate their children.

The federal government, far removed from the people and subject to interest group politics and the vagaries of international events, is supposed to be the broken institution. States, competing with each other and informed by grassroots common sense, are supposed to exemplify the genius of the American experiment. But reality is more complex. State governments are stumbling, taxing, and growing. Self-proclaimed fiscal conservatives aren't paying enough attention to big-ticket items such as Medicaid or to the long-term structural changes that could at least slow government's growth. And so they remain hostage to basic laws of voter preferences and bureaucratic behavior that push taxes and budgets ever upward.

Fuzzy Math

Numbers don't lie, although I can't say the same for their political abusers. The share of gross domestic product consumed by the federal government shrank for most of the 1990s, with rates of annual spending growth often in the low single digits. At the same time, state and local governments experienced an almost unprecedented growth spurt in both revenues and expenditures. Their share of GDP rose to nearly 13 percent in 2001, up from 11.4 percent in 1990.

Bill Clinton's federal budgets grew more slowly than George W. Bush's have, while the undeniable rise of Republican influence in state capitals during the 1990s did not necessarily result in fiscal discipline. Indeed, a USA Today analysis showed that from 1997 to 2002 Republican-controlled states saw slightly higher annual spending increases (6.85 percent) than Democrat-controlled states (6.79 percent). Taxpayers were usually better off when the governor and the legislative majority hailed from different parties.

The data reveal other surprises. So far, by most accounts, the recession that began in 2001 is one of the mildest on record. Yet also by most accounts, state governments since 2001 have experienced one of the most severe fiscal emergencies since the Great Depression. Is something unique and inexorable going on here?

Many alleged experts on government finance say so. Writing from academic roosts or from policy groups such as the Brookings Institution or the Center for Budget and Policy Priorities, they blame the current crisis on "structural problems" in state tax codes created by the New Economy, uncontrollable inflation in education and health costs, excessive tax cutting by the surging Republicans during the 1990s, and international trade policy. Supposedly non-ideological groups such as the National Governors' Association (NGA) and the National Conference of State Legislatures (NCSL) repeat and amplify these messages to a broader audience, as do gullible or ax-grinding reporters.

States are having trouble, NGA Executive Director Ray Scheppach declared on New Hampshire Public Radio earlier this year, because of "a perfect storm" of long-term fiscal trends. "Most states have systems sort of built for a manufacturing economy of the 1950s," he said, rather than for "a high-service high technology international economy of the 21st century. There's a deteriorating tax base. We don't tax services, and that's where growth is."

The reality is more prosaic. What we have seen in various states is little more than the confirmation of old maxims about how and why governments grow and what, if anything, can be done to arrest that growth. One useful way of thinking about this is to recognize that state lawmakers are obeying Parkinson's laws.

C. Northcote Parkinson, an oddball with an odd name, was a British novelist and historian whose output ranged from Napoleonic-era military fiction to a history of sea-borne trade. But his major claim to fame was Parkinson's Law (1957), which began a delightful series of books about how organizations make decisions, particularly bad ones. Here are some of Parkinson's best-known laws and how states are illustrating them:

1. "Expenditure rises to meet income."

In his 1960 book The Law and the Profits, Parkinson noted that bureaucracies, public and private, will usually find ways to spend pretty much whatever money comes in. That is, they don't build their annual budgets from the ground up. They discover the level of expenditure they can finance without breaking too much of a sweat, then work backward to justify that level as "essential" to meet the institution's "needs." The problem is exacerbated in governmental settings because there is no search for profit and few competitive pressures to tame the natural appetite for spending.

Among the states, it is notable that most of the governments with the biggest fiscal problems during the last two years don't fit the profile suggested by superficial media reports. Let me say first that I define "big fiscal problems" differently than some do. After a dozen years of experience closely watching a state legislature in action, in my home state of North Carolina, I can testify that projections of state budget deficits, which are what get reported to the outside world, usually are the result of political calculations as well as mathematical ones. So don't pay too much attention to whether a state "projects" a $1 billion deficit or a gap three times that amount. I can "project" a $100,000 deficit in my own household finances next year based on the fact that the vacation home my family "needs" to purchase cannot be financed at my current level of income. Similarly, governors and legislatures looking for excuses to raise taxes can and do manipulate budget numbers to project massive deficits on the basis of pie-in-the-sky expectations for state employee raises, new programs, and the like -- even excessive projections of growth in admittedly burgeoning programs such as Medicaid.

A better way to measure the relative magnitude of fiscal problems is what governors and legislatures actually do about them. Since 2001, reports the Rockefeller Institute of Government, 20 of the 50 states have enacted "significant" tax increases (amounting to at least 1 percent of general fund revenue), with 10 of those raising broadly applied tax rates on items such as individual income or retail sales. (The rest have mainly fiddled around with excises on cigarettes.) If the NGA/NCSL establishment is correct, then the states with the lowest rates of taxation to start with or the highest rates of expenditure growth over time, or both, would be the most likely to resort to tax hikes to bail themselves out of fiscal fixes. But no such pattern exists. About as many of these tax-raising states have fallen below the national average in spending growth in recent years as have exceeded it. Similarly, a slight majority of the tax-raising states were above average in tax burdens before the recent recessionary budgets, so it would be hard to argue that their resort to tax increases was due to some sort of basic inadequacy or to excessive tax cuts in the past.

The fiscal data offer even worse news for those who believe the states need to rely less on the archaic and regressive sales tax and more on progressive income taxes. This policy prescription is intended to head off future fiscal crises by allowing state revenues to track more closely the dynamics of our service-driven economy. Since a sales tax is essentially limited to physical goods, it is argued, it will inevitably fail to keep up with an economy increasingly composed of service industries that aren't taxed at retail. Income taxes pay no attention to whether goods or services are being sold and are thus supposed to be a more robust revenue source in the New Economy.

But seven of the 10 states that have been "forced" to raise broadly applied taxes in the last two years were already more heavily reliant on the income tax than the average state. And the only two states to have raised these taxes in both 2001 and 2002, New Jersey and North Carolina, already had the sharply progressive income tax systems that allegedly would be best. New Jersey had six rates that topped out at 6.37 percent for single taxpayers making more than $75,000. North Carolina's top rate was even higher: 7.75 percent for those making at least $60,000. (A 2001 tax bill added yet another rate of 8.25 percent for income above $120,000.)

Heavy reliance on progressive income taxes is actually a recipe for more budget woes. Other things being equal, it gets states into trouble because of what might be called fiscal turbulence. Rising incomes, supercharged in the 1990s by big capital gains, push more taxpayers into higher tax brackets. This accelerates the growth of tax revenues above the rate of overall growth in incomes and the economy. Flush with cash, state lawmakers create new programs to satisfy various "unmet needs": class size reduction, infrastructure construction, health care, and the like. Yes, they may also create a small savings account or toss off a few tax cuts to mollify fiscal conservatives, but rarely do they make fundamental changes such as lowering marginal rates. (Indeed, the much-hyped "deep" state tax cuts of the 1990s only partially offset the tax increases that legislatures had imposed during the 1990�91 recession.)

Of course, what quickly goes up can quickly come down. When boom yields to bust, and especially when capital gains booms yield to stock market busts, states dependent on progressive income taxes see their projected revenues fall faster than average as households and businesses shift to lower brackets. The result is a large, unforeseen hole in the budget.

Parkinson's insight here is that it's not really projected budget deficits or the perceived need for more spending that guides fiscal decision making. It's a breeze for politicians to justify new government expenditures, at least to themselves. What they struggle with is how to justify higher levels of taxation. They see recession-driven drops in revenue growth as prime opportunities to sell higher taxes. Rarely do they go back later, when the economy recovers and coffers are bulging, to repeal all or even most of their previous increases. It's a ratchet effect, similar to the one the historian Robert Higgs has observed in federal government growth during times of war.

2. "Work expands so as to fill the time available for its completion."

This is the most famous of Parkinson's laws. Anyone familiar with elastic deadlines can immediately grasp it.

In the state government context, the implications are subtle but critical. Most state legislatures operate under time constraints. They begin their regular sessions in January and end on a fixed date, often in March or April. But 10 states extend their regular sessions beyond four months a year, and another 10 operate without any meaningful restriction on how long they can meet in regular session. Interestingly, 13 of these 20 states are also among the 20 that have raised taxes during the last two years. Three additional states with lengthy legislative sessions -- New York, Missouri, and South Carolina -- may enact tax increases in 2003.

Why do legislatures that meet longer tend to end up with larger fiscal problems and a greater recourse to hiking taxes? Because the Parkinsonian "work" lawmakers do to fill the time allotted to them consists to a large extent of sitting in committee meetings at which a parade of government managers, state employees, and special interest lobbyists make the case for how much their pet program is "needed" and would be "sliced to the bone" unless the state raises taxes. Other "work" involves dreaming up new programs or pork barrel projects to attract media attention.

Furthermore, the longer a politician is parked in this big-government echo chamber, the more he or she forgets any previous convictions about limited government or the need for frugality. Average taxpayers, after all, don't spend much time lobbying and cajoling politicians in the often distant state capital. Studies from the Competitive Enterprise Institute, the National Taxpayers Union, and my own organization, the John Locke Foundation, have confirmed a version of this effect for long-serving members of Congress and state legislatures. The more years a politician spends in office, the more he or she votes for bigger government. It's no great stretch to expect a similar effect based on how much time state legislatures spend in session each year.

Sometimes the link is even more direct than that. Michael LaFaive, director of fiscal policy at the Michigan-based Mackinac Center for Public Policy, relates the story of how his state's legislature reacted in 2000 when an unforeseen surplus of $600 million materialized. By midyear it was already evident in the stock market and elsewhere that the national economy was clouding up. But instead of banking the funds for a rainy day, Michigan lawmakers went on a spending spree. "This might not have happened had we had a part-time legislature," LaFaive says, "because it probably wouldn't have been in town to react impulsively" to the discovery of the surplus. As it was, only two House members out of 110 voted against the spending measure, which included a $10 million polar bear exhibit at the Detroit Zoo and a $5 million aviation museum in Kalamazoo.

3. "The matters most debated in a deliberative body tend to be the minor ones where everybody understands the issues."

Whenever you hear state lawmakers waxing eloquently about how they are "cutting spending to the bone" by shuttering state aquariums, turning down the thermostat in state buildings, or sending state employees to fewer out-of-town conferences, you can see one of Parkinson's lesser-known laws in force. It is easy for politicians, the news media, and the general public to sink their teeth into these sorts of savings. You can gain of lot of rhetorical mileage out of anecdotes that involve relatively small amounts of money and evoke emotional reactions. Just a paragraph ago, I did it myself.

Still, bureaucrats misusing state vehicles to visit girlfriends and construction offices peddling contracts to pay off political contributors aren't the cause of growing governments and rising taxes. It's a good thing to find savings wherever you can, and certainly government-run attractions such as museums and historic sites should be generating their own fee income if the public is as enamored with them as their hand-wringing champions claim. But the real causes of burgeoning state governments are large, sprawling, lobby-infused programs, such as Medicaid and public universities, that too few lawmakers fully comprehend or are willing to take on.

Medicaid, the joint state-federal health care program for the disabled and the poor, is eating up an ever-increasing share of state general fund money. Expenditures grew by an average of 12.5 percent in 2002 alone, representing tens of billions of dollars in new spending. (Washington is paying 57 percent, while the states pick up 43 percent.) There is no shortage of sound explanations for why Medicaid is such a mess. Basically free to its beneficiaries, the program offers more benefits than the average private health plan does and thus encourages wasteful consumption of care. And as both Congress and the states expanded eligibility and the benefits package of Medicaid in the 1980s and 1990s, it became increasingly attractive for low-income persons, sometimes far above the federal poverty line, to adjust their finances (or at least what they reported their finances to be), drop their private coverage, and sign up for free health care.

Expansion has been particularly costly in health care for the disabled and elderly portions of the caseload, where much of the growth and a whopping three-quarters of the annual cost can be found. There is a fast-growing industry of lawyers and financial advisers specializing in ways for middle-class families to get their parents or other relatives qualified for Medicaid. The program now pays for two-thirds of all nursing home residents, nearly half of all births in many states, and the health care expenses of about a quarter of all children under the age of 5, with no real evidence that the health care outcomes are significantly better or that Medicaid expansion has had the net effect of reducing the ranks of the uninsured.

Even these facts do not fully capture the insidious impact of Medicaid and similar shared-responsibility programs on state budgets. Because Washington matches states more than dollar-for-dollar for Medicaid expenses, state policy makers have strong incentives not to pursue even obvious opportunities for savings. If they adjust benefits, tighten eligibility, rein in reimbursements, or just try to police fraud and waste better, they keep only a fraction of each dollar "saved," but they get all the public opprobrium. And this assumes the political actor has a deep knowledge of the program and its wacky finances in the first place. "The information deficit is huge," says Michael Greve, a scholar at the American Enterprise Institute. "Medicaid is intentionally and deliberately complicated. And when something goes wrong, [lawmakers] don't have anyone local to yell at. State officials point to D.C. and say, 'They did it.'"

Research by Greve and his colleagues shows clearly that recent Medicaid growth doesn't reflect the "we couldn't help it" line peddled by politicians and their handlers. States such as Florida and Arizona that attract high proportions of retirees "should be a basket case" when it comes to Medicaid inflation, Greve says, but the reality is that they have controlled costs better than most. Moreover, Medicaid spending has grown rapidly during boom years, not simply during recessions, when people lose their jobs and work-based health insurance.

In a further illustration of Parkinson's law that "expenditure rises to meet income," Greve and his colleagues also found that one of the strongest predictors of Medicaid growth in the 1990s was growth in state revenue collections. If state politicians saw money coming in, a combination of gullibility and moral hazard led them to spend much of it on the Medicaid monster.

Why the Laws Are Bronze

Not every state is in desperate fiscal shape and ravenous for higher taxes. Not every Republican governor spouting limited-government rhetoric turns out to be phony; some, such as Florida's Jeb Bush, Montana's Judy Martz, and Colorado's Bill Owens, really have controlled spending and held steady or even reduced their tax rates during the recent downturn. And the performance of both governors and legislatures in some states is proof that Parkinson's laws aren't forged in cast iron. They're made of wrought iron, or perhaps even bronze, and thus do have some room to give.

One fiscal strategy that sounds like a gimmick -- push-ing candidates to take a no-new-tax pledge, a core mission of the group Americans for Tax Reform -- has turned out to be surprisingly useful. Lingering pressure from their campaign stances has encouraged not only Illinois' Blagojevich but also new Democratic governors in Michigan, Oklahoma, Kansas, Virginia, and Arizona to resist hikes in broad-based taxes. When Republican lawmakers in particular vote to raise taxes after previously promising not to, the political blowback can be fierce. In North Carolina this year, the Democratic minority in the House allied with dissident Republicans to organize the chamber and, later, to pass the third major tax increase in as many years. Already some of the freshman Republicans in the coalition who betrayed their no-tax pledge are reconsidering their position as the folks back home find out and as potential primary challengers emerge.

On an institutional level, tax or expenditure limitations (TELs) have been valuable tools in the fiscal restraint arsenal. But not all TELs are created equal. A 2001 Cato Institute study found that measures placed into state constitutions or law by citizen referendum and requirements that taxes and spending rise no faster than inflation plus population growth have had large and beneficial effects on state budgets. But when legislatures pass mild revenue or expenditure caps, easy to evade and largely unenforceable in the breach, the result can be more spending from lawmakers who think they're behind political cover.

Setting up political or institutional counterweights to the public choice dynamics that drive government growth in state capitals can yield some fascinating and hopeful outcomes, especially when accompanied by serious attempts to organize taxpayer lobbies, free market think tanks, and alternative media conduits for political information. For the first time in decades, for example, governors and legislators under fiscal pressure are rethinking their slavish devotion to pouring massive funds into state university systems. Colorado, with both a political tailwind and a strong TEL, is considering a voucher system for higher education to replace its current set of institutions and subsidies. College administrators themselves are proposing more-limited privatization measures for state systems in Massachusetts, South Carolina, and Wisconsin. On the Medicaid front, Florida and a handful of other states are experimenting with a defined-contribution approach that gives patients more financial incentives to shop wisely and more choices about where and what to buy. The early results look encouraging.

No reforms or political victories, however promising, can repeal the basic laws of government finance. Politicians will continue to tax. They will continue to spend. And they will continue to spin, holding endless conferences and issuing countless reports to justify their actions. Parkinson got that one exactly right when he reportedly told a lecture audience: "Government's handling of a difficult matter by appointing a commission...is just like a person going to the toilet. There is a sitting, a report, and then the matter is dropped."

Tax Reform Schools

info@reason.com (John Hood) — Sun, 01 Nov 1998 00:00:00 EST

George Bush delivered a big tax cut, and conservatives pummeled him for it. No, not that George Bush. I'm talking about Texas Gov. George W. Bush, son of the former president and (for wont of anyone else with star quality) the putative front-runner in the 2000 GOP presidential field. Last year, after months of testy debate with state lawmakers, he engineered a $1 billion property tax cut. Even for Texas, the nation's second most populous state, that's hefty tax relief. Yet the governor's notices, particularly among Republican power brokers and D.C.-based conservative activists, were terrible.

Bush's bad reviews shed light on the political dynamics of the national tax reform debate that Steve Forbes kicked off during his 1996 presidential run. The experience in Texas reflects the obstacles that tax reform has encountered in state capitals across the country. This year, tax cuts totaling $4 billion to $5 billion have been or will be considered in about 35 states. But tax reform has yet to gain any ground, and in many ways state and local tax codes are moving further from the neutrality, simplicity, and equality that reformers seek. The main problem is that fundamental tax reform inevitably means higher taxes for some. In a war between those seeking tax cuts and those protecting themselves from tax hikes, the latter will almost always win. To get past this obstacle, reformers may have to scale back their immediate goals.

The push for reform in Texas began with a tax system widely perceived as out of whack. Texas is one of five states without an individual or corporate income tax. The average state derives 40 percent of its revenue from income taxes, a third from sales taxes, and the remainder from levies such as business licenses and gasoline taxes. Texas, by contrast, gets half of its revenue from a sales tax, and it relies more than most states on local property taxes to pay for public education and other services. Its sales tax rate (6.25 percent) and its property tax burden are correspondingly high.

Lacking a corporate income tax, Texas imposes a disproportionate share of its business tax burden on capital-intensive industries, such as manufacturing, oil refining, and mining, that own a lot of taxable real property. According to a study by the governor's office, in 1997 the average property tax in the capital-intensive segment of Texas business was $5,300 per employee, compared to $595 per employee in labor-intensive businesses. "The bottom line is that the Texas economy has changed rather dramatically since the current structure was put into place," Austin attorney and tax reform activist Chris Shields told the Austin Business Journal in January of last year. "Asset-backed companies represent one-third of the economy but pay two-thirds of the school property taxes."

Elected governor in 1994, Bush started talking about the Texas tax code the day after the 1995 legislative session adjourned. The legislature had just adopted all four of Bush's key campaign promises: tougher juvenile justice laws, tort reform, welfare reform, and local control of schools. The governor was on a roll, and he decided to push on, into the tax thicket. Ruling out the adoption of income taxes, Bush put together a blue-ribbon panel to study ways to reduce property taxes and reform the financing of public schools.

In January 1997, Bush was ready to release his plan. It had four major components: 1) a big cut in school property tax rates in each of the state's 1,044 school districts; 2) a five-fold increase in the property tax homestead exemption, to $25,000 per home; 3) a half-cent increase in the motor vehicle tax and the statewide sales tax; and 4) a new 1.25 percent "business activity" tax to replace the state's franchise and property taxes on business. It would have applied only to companies with at least $500,000 in sales.

Overall, Bush's plan offered property-tax payers a projected $2.8 billion cut the first year and $6 billion over the budget biennium, translating into a 40 percent reduction of the average homeowner's tax bill as well as significant tax savings for businesses with lots of taxable property or inventories. All but about $1 billion of the initial tax relief, however, was offset by the increased tax rates on retail sales and motor vehicles and increased taxes on some service-sector businesses. In addition, the Bush plan would have shifted the main responsibility for funding schools to the state.

One can quibble with the details of Bush's plan. I wouldn't have structured it the way he did. But its fate at the hands of special interest lobbies in Austin should serve as a cautionary tale for flat taxers and sales taxers at the national level.

Keep in mind that Bush did a lot of things right. His plan offered a large net tax cut. And soon after announcing it in his 1997 State of the State address, the governor embarked on a speaking tour around Texas, generating significant public interest and media attention. The details of the plan were widely reported. For the first few weeks, both Democrats and Republicans in the state legislature were cautiously optimistic about the plan's prospects. But one prescient business lobbyist told the Abilene Reporter-News that Bush's pitch wasn't going to be easy. "I think tax reform is not a hard sell," he said. "But specific tax reform is a hard sell. The closer you get to specifics, the harder it becomes."

The state's business community quickly took sides. The Coalition for Property Tax Reform and trade associations for manufacturers, oil and gas companies, farmers, and ranchers all applauded the plan. Small-business groups, even those in retail and service industries, also liked the plan because of the $500,000 standard deduction from the new business activity tax. On the other hand, the Texas Retailers Association, the Texas Restaurant Association, and state associations of doctors, lawyers, and other professionals organized as partnerships announced their opposition. Some of these firms would have been subject to significant state taxation for the first time.

Another aspect of the new business activity tax that sparked opposition was the proposal to count employee compensation, including nonwage benefits and payroll taxes, as part of the tax base. Critics argued that taxing fringe benefits would reduce the likelihood that employers would offer them, and that imposing a state tax on Social Security, Medicare, and unemployment insurance contributions amounted to double taxation (of course, this already happens with the employee share of payroll taxes, which is included in a worker's income tax base).

To his credit, Bush attempted to defend his tax reform plan on the basis of treating taxpayers equally and minimizing state distortion of the economy. At an appearance in Amarillo in early February 1997, he was peppered with questions from doctors and lawyers. "An attorney might say that he shouldn't have to pay tax" for the legal services he dispenses, Bush said. "I say, why?" To exempt service industries from taxation, he continued, makes no sense in a modern economy where traditional manufacturing and extractive industries make up a smaller share of output.

This is a critical point. Most of what state governments do today--funding schools and colleges, for example, or paying for Medicaid and other social services--theoretically benefits taxpayers regardless of how much property they own. If taxes are designed as rough user fees, to be imposed according to a "benefit principle" that aims at neutrality and tries to minimize cross-subsidies, then these services (if provided by government at all) aren't properly funded by archaic property or franchise taxes that don't spread the burden equally. On the other hand, such functions as law enforcement and transportation especially benefit those with lots of land or expensive property and thus might still reasonably be supported by property taxes.

The governor made another point about neutrality. He noted that under the current Texas tax code, corporations are forced to pay extra taxes that partnerships and other business entities don't. "In today's world," Bush said, "multimillion-dollar partnerships compete for business with corporations, yet they escape tax liability." Income earned by corporations is often taxed two, three, or more times as it flows from the business to stockholders and eventually to their heirs. Income earned by other business forms usually is taxed only once or twice.

Two companies demonstrate the uneven impact that Bush's plan would have had. Southwestern Public Service Co., an electric utility, estimated that Bush's plan would cut its property tax liability by $4.2 million. On the other hand, Amarillo-based Wonderland Amusement Park projected a 27 percent increase in taxes. "A labor-intensive business, such as we are, will have a lot of problems with the proposals," said Wonderland President Paul Borchardt shortly after Bush announced his plan.

That was putting it mildly. By the time the state legislature started working on the plan, Bush's business activity tax was already doomed. As the proposal worked its way through the legislative meat grinder, both chambers rewrote it. The majority-Democrat Texas House passed an even higher property tax cut than Bush had proposed but also approved more offsetting tax increases, including an attempt to widen the state sales tax base to include some services (Texas, like most states, has a narrow sales tax base that excludes most services and thus taxes lower-income families disproportionately). The Senate, with a 17-14 Republican majority, voted down this package. With the state GOP chairman criticizing Bush's approach as anti-business and pro-tax, the Senate fashioned its own plan, including smaller property tax cuts and little reform. Other ideas, such as extending the state franchise tax to partnerships and raising taxes on insurance premiums, were also floated.

Differences between the two chambers, the governor, and lobbyists for professionals and business interests led to stalemate by late May. With only days left in the 1997 legislative session, Bush and lawmakers settled for just one element of the governor's original plan: a constitutional amendment to increase the homestead exemption. Texas voters overwhelmingly approved the $1 billion tax cut amendment in a referendum two months later.

Again, I don't want to suggest that Bush's solution to the Texas tax morass was necessarily the best one. Some might argue against a shift of responsibility for school financing from local governments to the state (I happen to think that's a good idea). Others might question the wisdom of enacting what amounts to a value-added business tax and widening the tax base, both of which create the risk of government growth in future years because of the increased revenue that a relatively small rate hike can yield.

These concerns aside, however, the Texas experience illustrated virtually every political barrier that a flat tax or national sales tax would confront in Washington. Insurers and other providers of employee benefits went ballistic over Bush's proposal to tax nonwage compensation. Lawyers, doctors, and other professionals lobbied strenuously to keep their industries from being subjected to a new tax. Fiscal conservatives opposed the plan, despite the fact that it represented a net tax cut, because it raised rates in some areas and on some industries. Bush got awful national press in conservative media outlets such as The Wall Street Journal, which zeroed in on the part of the package that raised rates rather than recognizing it as a serious, albeit flawed, attempt to reform an outdated, complicated, and economically distorting tax system.

The fact is that sweeping tax reform would raise taxes on some individuals and companies. A flat tax would, and so would a national sales tax. Furthermore, both increase the potential revenue from future tax rate hikes by widening the tax base. Despite the differences in detail, if Bush's plan wouldn't fly in Austin, fundamental tax reform as currently envisioned won't fly in Washington, especially once a Republican Congress starts reading the fine print and getting phone calls and letters from irate doctors and insurance agents.

There's yet another reason to rethink the viability of comprehensive tax reform. Business lobbies have increasingly been abandoning any philosophical commitment they might once have had to a neutral tax code in favor of targeted breaks for specific industries or particular companies. These provisions, known as "economic incentives," are punching holes in state tax codes across the country and souring ordinary voters on the tax reform process.

Auto manufacturers such as Mercedes-Benz and BMW receive multimillion-dollar tax breaks to locate in Southeastern states. New York, New Jersey, and Connecticut play property tax tag with corporate headquarters. In August 1993, Illinois Gov. Jim Edgar helped put together a resolution against state relocation subsidies for corporations that was adopted by the National Governors' Association. Just before Edgar left Springfield for the NGA meeting to announce the truce, he approved an incentive deal with Tootsie Roll Industries that included $1.4 million in state and local tax exemptions. Right after he returned from the NGA meeting, Edgar offered a $30 million tax incentive package to woo a Nabisco plant.

As Edgar's behavior suggests, interstate agreements on corporate tax loopholes are about as effective as international agreements on arms. The incentive to cheat is high. Since the well-publicized multistate rivalry for new Nissan and Saturn auto plants in the mid-1980s, almost every state has offered or given special tax breaks, enacted general tax-incentive policies such as per-job corporate tax credits or enterprise zones, or both. Rather than moving in the direction of flatter, fairer, more neutral tax codes, states and localities are sprinting as hard as they can in the opposite direction.

Indeed, in some ways state tax codes are worse than the national system. The federal code has four income tax brackets. Of the 44 states with individual income taxes, 18 have five or more brackets, including Iowa and Ohio with nine and Missouri and Montana with 10. Some states have more than one corporate income tax bracket, not including the credits and exemptions that in effect create many more tax rates. States with retail sales taxes almost invariably exempt services from the tax base, and many have lower or no taxes on the retail sale of food, drugs, and other "necessities."

My own experience in North Carolina has been sobering. As much as business leaders in my state say they would like to see the overall corporate tax rate lowered, they spend far more time and money seeking incentive packages for specific companies (most recently for FedEx and Nucor Corp., both longtime heroes of free marketeers), along with general policies giving tax breaks to companies that locate in particular counties, pay certain minimum wages, and otherwise do what state politicians want them to do. This form of industrial policy should disturb anyone committed to tax reform or free enterprise.

The fact that there are political barriers to tax reform does not mean the cause is doomed. Rather, reformers will need to design discrete, incremental policies that are consistent with the principles of tax neutrality and simplicity yet salable to lawmakers and voters.

A good example is the reduction or elimination of taxes on cars. Jim Gilmore got elected governor of Virginia last year largely on this issue. Other sitting and would-be governors are following suit. In states where most or all car taxes go to dedicated highway funds, the issue is muddy at best, demagogic at worst. But in many states, money from property or use taxes on automobiles goes to the general fund, thus imposing an unjustified special tax on a single product. In these jurisdictions, eliminating car taxes, as well as special excise taxes on cigarettes and liquor, is both a popular campaign issue and a step toward neutrality.

Another example of incremental reform is giving the self-employed and those who work for small businesses the same tax breaks on their health insurance that people who get employer- provided coverage already enjoy. We had some success with this issue in North Carolina. In April, the state legislature passed a $65 million tax credit for families that buy health insurance for their kids. Lawmakers were persuaded that to do less was to continue to give breaks worth more than $1,000 per child in federal and state taxes to relatively affluent white-collar employees while denying them to self-employed plumbers and retail clerks. U.S. Rep. Bill Archer (R-Texas), chairman of the House Ways and Means Committee, has proposed a similar health care credit at the federal level. This change, of course, does not eliminate the special exemption for medical insurance; it just spreads the exemption more evenly across the population. But because it eliminates a bias in the tax base, it is consistent with tax reform.

Yet another step at the federal and state level would be creating and expanding tax-free savings accounts for medical care, education, unemployment compensation, and perhaps other purposes. Since the tax-reform argument for these policies is often misunderstood, let me explain a bit. First of all, a cardinal rule of neutral taxation is to stop punishing savings. For nonretirement accounts, we violate this rule by double-, triple-, or quadruple- taxing investment income, particularly that from corporate stocks. Taxing all forms of income or consumption only once means exempting either the principal or the earnings. Either a "front-ended" savings account that exempts deposits but taxes withdrawals or a "back-ended" account that taxes deposits but exempts withdrawals is consistent with tax neutrality.

For medical savings accounts, not just the deposits but also the withdrawals should be tax-free. That's because the current tax system makes health care consumption via insurance completely tax-free: Neither the premiums you pay insurers nor the services you receive are considered taxable income. Tax neutrality demands that medical savings, as an alternative to insurance, receive the same tax treatment.

The argument for tax-exempt educational savings accounts is a bit different. Education isn't just an alternative way to consume one's income. Often, it is an investment in skills and credentials that will yield a future return in higher (and taxable) wages. Just as the purchase of machinery or equipment should be tax-deductible, because it generates future taxable income, so should some training and education expenses paid by employers or employees. An educational savings account into which you can deposit several thousand dollars a year tax-free, and from which you can withdraw unlimited amounts tax-free, is defensible on tax policy grounds (as well as being an attractive means of enabling families to exercise school choice without the regulatory problems that vouchers might bring).

Other possible reforms include making payroll taxes deductible from income taxes (a must if Social Security privatization becomes feasible) and expanding the lower income tax brackets so more taxpayers pay the same rate (thus reducing the revenue loss from a subsequent elimination of the higher rates). The key is to pick ideas that generate strong political constituencies of their own while avoiding the mistake of raising taxes on other powerful constituencies.

Tax cutters fall along a continuum, from pure flat taxers and national sales taxers to corporate types who lobby for special rates, credits, and exemptions. Successful tax reformers will chart a middle course between these two poles, finding ways to promote ambitious ends through targeted means. As Bush discovered, how tax reform will be greeted by lobbies and perceived by voters is just as important as its theoretical underpinnings.

Grassroots Graft

info@reason.com (John Hood) — Sat, 01 Aug 1998 00:00:00 EDT

Let me stipulate right up front that Washington is a fetid swamp of scandal. During the past two decades, whatever respect Americans might have had for their national political leaders has steadily sunk into the soft muck of Watergate, Abscam, Iran-Contra, Whitewater, Filegate, Chinagate, Fornigate, etc.

I'll make a bold statement, however. Government corruption is less rampant in Washington than in Albany, Sacramento, or (especially) Little Rock. It is striking that many of the Clintons' most egregious ethical lapses--involving state pension funds, kickbacks, shady land deals, illegal federal loans, and cattle futures--occurred while Bill was governor of Arkansas. Presidents and congressmen make headlines with giggling interns and intricate campaign finance irregularities. State politicians still do it the old-fashioned way: lobbyists with sacks of money, all-powerful committee chairmen who give themselves state contracts, business executives who pay cash for government appointments or regulatory nods.

State officials do this sort of thing a lot--mostly because they keep getting away with it. They typically face less scrutiny than national politicians do, and they have many opportunities to enrich or impoverish individual firms. By contrast, Congress does things that affect whole industries, making it simultaneously more powerful and less amenable to garden-variety graft.

While political observers can count on a couple of hands the federal legislators who've resigned in disgrace during the last decade--Dan Rostenkowski and Bob Packwood come to mind--recent scandals in state legislatures have embroiled dozens, if not hundreds, of lawmakers in tawdry investigations and costly prosecutions. In the last few years, newspapers have been rife with stories of corruption in states such as Arizona, South Carolina, Rhode Island, Kentucky, New York, New Jersey, New Mexico, and Massachusetts. And no one knows what the final body count will be in poor Arkansas, where the Whitewater investigation has turned into a broader scandal of bid rigging, insider deals, and thievery throughout state government.

Let me illustrate my point about state corruption with a few examples. Beginning in the late 1980s, the Kentucky state legislature underwent two major scandals, both involving regulatory oversight.

In the first case, lawmakers enacted measures in 1988 and 1990 that hurt a small harness racing operation on the Ohio River. Its owner sought relief in the state capital, only to be told by a prominent lobbyist that it would probably cost around $100,000--in campaign cash to various lawmakers--to make his problems go away. The racetrack owner, to his credit, didn't pay up. Instead, he went to the FBI, which began an elaborate sting to catch lobbyists and lawmakers in the act of buying and selling votes for cash. The feds eventually netted 11 bribery convictions, including one involving the speaker of the state House.

The second Kentucky scandal involved health care regulation. Humana Inc., based in Louisville, got a special exemption from state licensing rules for some of its health care facilities. Later, an investigation found that a Humana vice president had paid $10,000 for the necessary legislative votes. Kentucky's penal system swelled again.

Rhode Island politicians were also buffeted by corruption charges in the early 1990s. The wide-ranging scandal involved a mayor taking kickbacks from city vendors, a former governor fined for steering state contracts to his political supporters, and judges tripped up on bribery and fraud charges. In perhaps the most colorful incident, state police put a North Providence clothing store under surveillance based on a suspicion that mobsters regularly met there. The suspicion proved correct but incomplete: One regular attendee at the meetings was the chief justice of the state Supreme Court, who later resigned.

This case may sound like a DeNiro movie treatment, but it's hardly unique. Many state scandals feature dramatic scenes. In "AzScam," the Grand Canyon State's brush with slime, a state representative in line to chair the House Judiciary Committee was caught on camera bringing a nylon gym bag to the office of a lobbyist and stuffing $55,000 into it. Another Arizona lawmaker was actually caught on tape saying, "I don't give a [expletive] about issues....My favorite line is, `What's in it for me?'" If that bit of dialogue were used in a screenplay, it would be ridiculed as unrealistically blunt.

I used to think my home state of North Carolina--where I run a think tank, the John Locke Foundation--was different. During the past two years, I've discovered how wrong I was. It all started the day after Christmas in 1996. Entering a crowded supermarket, I picked up a copy of a local black-owned newspaper to read in the checkout line. I was greeted with a glowing story about two local politicians, elected to the state Senate the previous month, who had given out $100,000 in "discretionary funds" to several nonprofits in minority neighborhoods. "That's my Merry Christmas present," said one of the senators-elect. "[We] are already having a positive effect."

The notion of passing out taxpayer money like Christmas candy was bad enough. But then I started to wonder how someone who had not yet taken office, much less served long enough to slip some pork into the state budget, could get his hands on "discretionary funds." After some digging, reporters for the Locke Foundation's Carolina Journal discovered that the money had come from a secret $21 million slush fund, known to only a few legislative leaders. The money had been "reappropriated" from surplus funds in a reserve account for the repair and renovation of state buildings. As is typical of such shenanigans, negotiators had inserted the reappropriation with four cryptic lines in the middle of the night during the previous year's state budget deliberations.

Legislative insiders and their political consultants doled out this money with abandon. Several grants were timed to help embattled incumbents cut ribbons a few weeks before an election. In other cases, the money appeared to be payback for favors done by rank-and-file lawmakers or wealthy contributors.

The grants were hard to justify on policy grounds. Wealthy Pinehurst, home to some of the world's ritziest and most famous golf resorts, got money for a new fire truck. Several senators and representatives steered money to local nonprofits which they served as board members. The Andrew Jackson Memorial and Museum, located along the South Carolina line near a "birthplace" most historians view as mythical, got a $200,000 check--twice its annual operating budget. The same state senator who obtained that grant (and who serves on the museum's board), gave government money to another nonprofit (for which he is also a board member) in a revealing manner. According to a local newspaper, The Enquirer-Journal, he attached the check to a football and threw it across the room to the group's founder during a benefit roast. It seems that dispensing taxpayer money had become a game to him and many of his colleagues.

Some lawmakers used the money to entice private groups onto the public dole. In one case, Playspace, a nonprofit museum and entertainment facility for children in Raleigh, had been on the verge of establishing itself as a self-sufficient organization. After years of receiving state and local grants, Playspace had ended its grant requests, planning to rely on admissions and membership fees as well as private donations. But in December 1996, at the urging of Sen. Eric Reeves (D-Raleigh), Playspace accepted a $5,000 check from the state.

Legal action on some of the improprieties we uncovered is pending. But to our dismay, the slush fund scandal was only the beginning. The Locke Foundation began receiving a steady stream of anonymous tips about wasteful spending and political influence. In 1996, a former employee of the state's Division of Motor Vehicles named Algie Toomer received a controversial $100,000 settlement from the state for employment discrimination. As lawmakers convened hearings in 1997 to investigate the matter, we obtained an exclusive interview with Toomer and his attorneys. He told us about illegal campaign fund raising among rank-and-file DMV employees.

There seemed to be a climate of "pay to play" at the DMV, with workers not so subtly promised that the governor would be apprised of their financial support or lack thereof. On a single day in February 1995, Toomer and some 80 of his Department of Transportation colleagues made contributions to Gov. Jim Hunt's 1996 campaign kitty. More than one-third of the employee donors received pay raises or promotions within a couple of months. According to a report by the watchdog group Democracy South, the contributions were often collected and "bundled" by politically appointed DOT supervisors, who used the cash to strengthen their connections to the governor's office.

By the time we published Toomer's allegations in the August 1997 Carolina Journal, the rest of the news media had begun their own scandal investigations. In September, The (Wilmington) Star-News reported evidence that the governor, his secretary of transportation, Garland Garrett, and his campaign finance director, Jim Bennett, had promised a seat on the North Carolina Board of Transportation, a powerful appointed panel, to a campaign contributor for $25,000. The allegation came to light because the donor, James Allen Cartrette, didn't get the appointment and started complaining about it.

Is selling a government post and then reneging on the deal, among other things, a case of mail and telephone fraud? Columbus County District Attorney Rex Gore looked into the matter and decided not to indict anyone, but he made it clear that he believed the charge. "I personally believe that Mr. Cartrette fully expected to get a DOT position," he said. "I personally believe that Mr. Garrett and Mr. Bennett did little to lead him to believe otherwise. I might get a conviction at the corner store, but I could not in the courtroom." A federal investigation is ongoing.

Another spate of news stories, in The Charlotte Observer and The (Raleigh) News & Observer, reported that several Board of Transportation members--and even, in at least one case, the governor himself--had pushed for highway projects to benefit themselves or political patrons. In August 1997 the Locke Foundation joined with three left-of-center policy groups in a joint request for a state performance audit of DOT and prosecution of wrongdoers. The resulting audit called for significant changes in DOT structure and operations.

The problems in North Carolina's transportation department--from excessive politics to insider dealings and mismanagement--led to the resignation of the secretary of transportation, the state highway administrator, and two board members. In February 1998, the FBI, the U.S. Department of Transportation, and the Postmaster General's Office (which handles mail fraud) announced a wide-ranging investigation of North Carolina's DOT.

Last year, the governor announced reforms aimed at reducing the number of patronage employees in the department and tightening procedures for hiring and promotion. State lawmakers are debating DOT reforms that include downsizing the board, tightening ethics guidelines, reorganizing and privatizing transportation divisions, and handing over highway revenues and authority to local governments.

You might think this long ordeal has validated rather than tarnished the processes through which North Carolina fights corruption. After all, the news media, with a little prodding, did leap into the fray. The legal system, creaking and groaning all the way, did begin investigations and forced some crooks from office. Hunt was forced to cede some power and go through the toughest political scandal of his career. Yet the governor's approval numbers are through the roof. North Carolina voters have either tuned out the scandal stories or concluded that "everyone does it, so why pick on Hunt?"

State corruption is far harder to combat than corruption in high-profile Washington or in local government, where decisions receive more local media coverage and where citizens can attend meetings and corral officeholders. States are the middle, "missing" layer of government. Press contingents in state capitals have been shrinking for years. Many voters lack basic information about who governs their state and what they do.

It will take more than exposés and lawsuits to clean things up in state capitals. It will take basic changes in what state governments do and how they do it. Here are a few of the most important reforms:

Toughen civil service and contracting rules. I was a reluctant convert to this idea. I used to think that rigid rules for hiring state employees and awarding contracts were unnecessary impediments to running government more like a business. Now I recognize the truth: Government can't and shouldn't be run like a business. It doesn't face the discipline of the profit motive. It relies on attitudes and behaviors fundamentally different from those confronting entrepreneurs. The alternative to civil service protections for employees is not a merit system but selling jobs to campaign donors. Exempting state agencies from bidding procedures means buying office supplies from an agency head's cousin.

Cut back regulation. There are good economic and moral reasons for minimizing the encroachment of the state into private decisions. But one of the most persuasive arguments is that appointments to regulatory agencies and specific regulatory decisions are often bought by high-dollar donors. One glaring example is nursing home regulation, as the Kentucky case showed. In many states, operators who want to open new homes must obtain a "certificate of need" from state regulators. Coupled with state authority over nursing home reimbursements from Medicaid and other programs, this power makes the nursing home industry a reliable source of campaign cash. Other big campaign players in most states include the gaming industry, real estate developers, home builders, and health care lobbies such as optometrists and chiropractors--all of which worry about regulation.

Fight pork-barrel spending. While discretionary funds tapped by lawmakers for pet projects in their districts make up a relatively small percentage of most state budgets, they consume a tremendous amount of time and result in a disproportionate amount of corruption. Consider state funding of the arts. While the Locke Foundation has long opposed such spending on principle, over the short term we have settled for reforming the process by which the money is distributed. Grants to local arts groups now must go through an open process of application, priority setting, merit consideration, and approval, which will reduce the amount of logrolling and waste.

As long as human nature remains what it is, there will be potential for official corruption. Government will always be necessary to carry out essential functions such as law enforcement. For the foreseeable future, education and some kind of social safety net are likely to remain government responsibilities as well. Finding ways to carry out these functions without buying and selling influence is a critical challenge, one that advocates of limited government should make their own.

Getting Beyond Racism

info@reason.com (John Hood) — Fri, 01 May 1998 00:00:00 EDT

America in Black and White: One Nation Indivisible, by Stephan Thernstrom and Abigail Thernstrom, New York: Simon & Schuster, 704 pages, $32.50

Bill Clinton is a profoundly silly and trivial man. To come to this conclusion, you need not believe Monica Lewinsky, Gennifer Flowers, The New York Times, and the vast right-wing conspiracy that funds them, controls them, and brings them coffee. All you need to remember is how Bill Clinton arched his eyebrows, deepened his drawl, and wagged his finger at Manhattan Institute scholar Abigail Thernstrom last January at the University of Akron. In that celebrated exchange, part of the president's national "conversation" on race, Clinton--impersonating Geraldo Rivera on a bad day--asked participants whether they supported affirmative action in higher education. Thernstrom interjected, correctly, that the real question was whether racial preferences, not some vague concept of "affirmative action," ought to continue.

"Abigail," said the president in mock familiarity, towering over her as she sat in her chair, "do you favor the United States Army abolishing the affirmative action program that produced Colin Powell?" When she hesitated, he pressed on. "Yes or no?" he demanded. "Yes or no?"

Thernstrom refused to take the bait, and began: "I do not think that it is racial preferences that made Colin Powell...."

"He thinks he was helped by it," the president interrupted.

This is, apparently, the kind of conversation that the president would like to foster on race: superficial, bullying, and misleading. That Thernstrom wouldn't play along will come as no surprise to readers of America in Black and White: One Nation Indivisible, the new book she wrote with her husband, Stephan, a Harvard historian. America in Black and White is long (704 pages with notes), detailed, and full of numbers. It is also one of those books likely to end up dog-eared, worn, and kept within the easy reach of journalists, policy analysts, and others interested in these issues. It's a magnum opus that, one might hope, will do for issues of race what Losing Ground did for welfare policy or Capitalism and Freedom did for free market economics--that is, move an important issue out of elite discussion and into public view, helping to shape attitudes and opinions over time.

If it's about race, it's in here. The Thernstroms examine affirmative action, desegregation, busing, college admissions, redistricting, employment, poverty, housing, and culture. While the picture they paint of race relations and racial progress is complex, it is ultimately rosy. The gap between blacks and whites has shrunk dramatically in many areas, from incomes and living standards to educational attainment. This fails to comport with the world view of worrywarts, liberal and conservative, who view the racial divide as yawning and possibly unbridgeable. Many problems remain, of course, but the Thernstroms persuasively argue that to deny the past five decades of progress is to prevent serious debate about what remains to be done.

As a compendium of statistics and trends, the book is unsurpassed in its breadth and depth. Indeed, the only quibble that I have with America in Black and White is that, in some places, the intensity and complexity of the argument seemed like overkill. I felt as if, having already been pinned on the mat, I was being pummeled about the face and neck with a seemingly ceaseless flurry of jabs. Of course, I hadn't put up much of a struggle in the first place. Surely other readers need convincing a lot more than I do--and if their minds are open, the Thernstroms will persuade them.

As I read the book, I marked nuggets of unique insight about the sometimes surprising course of race relations, particularly as it intersects politics. The Thernstroms begin with an excellent history of slavery and Jim Crow segregation, the details of which still have the power to shock us today. One interesting fact they report is that while Southern hotel operators and (after some early resistance) bus and streetcar companies acquiesced to segregation--the power of white social consensus overcoming the search for profit--gas stations never did (except in their restrooms). "Filling up the tank was such a transitory and impersonal experience that service station operators would not sacrifice profits in order to indulge their prejudices," they write. Indeed, the advent of the automobile in the 1920s threatened much of the segregationist order, leading many cities and towns to attempt to impose "racial rights-of-way" at intersections and on lanes. It never really worked--reflecting, if you think about it, the natural tendency of the automobile to promote personal freedom in contrast to mass transit's susceptibility to social or political control.

Throughout the book, the Thernstroms challenge simplistic assumptions about the political and economic history of race. I didn't know, for instance, that right after the Brown v. Board of Education decision, a Gallup poll found that black Americans were almost evenly split as to the wisdom of school desegregation, many either resentful of the "proximity theory" that black kids could learn only with white kids nearby or suspicious of efforts to dismantle the black public schools that had long been important institutions, and employers, in black communities.

Similarly, the Thernstroms discuss black ambivalence toward Roosevelt's New Deal. Though it coincided with increased black support for the Democratic Party, in many cases the New Deal harmed black economic interests--for example, by imposing a minimum wage that led to massive unemployment in the Southern tobacco industry. The black press even referred to the National Recovery Act, which may have thrown half a million blacks out of work, as the "Negro Removal Act." Even so, the black voting population that had backed Herbert Hoover in 1932 had by 1936 become one of Roosevelt's strongest bases of support. The authors ascribe the change more to the liberal views of FDR's advisers, such as his wife, Eleanor, and Interior Secretary Harold Ickes, than to the economic policies they designed and carried out. Also helping to change attitudes was the president's tacit policy of increasing employment of blacks in federal agencies.

Still, the political allegiances of many prominent leaders of the emerging civil rights movement remained complex. When Jack Kennedy ran for president, he met with Martin Luther King Jr. to solicit his support. King's father was a Republican, and the younger King said that he could not see "that there was much difference between Kennedy and Nixon." He declined to endorse either. But subsequent events proved Nixon's downfall. A couple of weeks before the election, a Georgia judge threw the younger King in jail for a traffic violation. Kennedy called Coretta Scott King to express his sympathy, while Bobby Kennedy persuaded the judge to spring him. Nixon, meanwhile, chose to remain silent, resisting the entreaty of baseball great Jackie Robinson, a Nixon supporter. "On election day Martin Luther King, Sr. voted for Kennedy, and so did hundreds of thousands of other African Americans," the Thernstroms write. This represented a modest jump in black support for the Democratic ticket--about nine percentage points--but enough to account for Kennedy's slim margin of victory.

Of course, the flip side of growing black support for Democrats was increasing Republican strength among whites. Southern white voters began the trend in the early 1960s, but as the decade progressed, and in particular after the civil rights acts of 1964 and 1965, many Northern whites grew uneasy about federal policy, too. In February 1964, only 28 percent of Northern whites thought the administration was moving too fast on integration, but by September 1966 more than half thought so. While Kennedy had received 61 percent of votes cast by white unskilled or semi-skilled workers, Hubert Humphrey received only 38 percent of such votes, the remainder going to Nixon or George Wallace. By 1972, even traditionally Democratic union members chose Nixon over George McGovern.

There were other issues in these races, of course, but disaffection with policies such as forced busing clearly hurt the Democrats among whites. Fortunately, these race-based political trends have begun to burn out, according to the Thernstroms. Majority-white cities and states are now electing black mayors or governors, and some Republican statewide candidates are polling well among blacks (Gov. George Voinovich of Ohio got about 42 percent of the black vote in his last bid for reelection).

The Thernstroms are at their best in marshaling economic and social science research to disprove the nostrums of modern racial liberalism: that blacks haven't made much progress in the past three decades, that the progress that has been made was because of racial preferences, and that racial discrimination is the most important explanation for continuing gaps between whites and blacks in income, wealth, education, and other measures of social well-being. For example, the black poverty rate fell from 87 percent in 1940 to 30 percent in 1970, and by 1995 had slipped further to 26 percent. This remarkable change can hardly be ascribed to anti-discrimination laws or affirmative action policies that weren't implemented until the late 1960s.

The news is not all good, however. After all, the white poverty rate in 1995 was only 9 percent. Why the continued disparity? The Thernstroms persuasively argue that the decline in marriage and the corresponding increase in out-of-wedlock births, occurring nationwide but reaching far higher levels among blacks, explain the persistence of the poverty disparity far more than other factors.

They also report the sad news that after converging since good national tests began in the early 1970s, the reading and math scores of whites and blacks began widening again in the mid-1980s, possibly because of increasing school violence and a growing unwillingness to apply rigorous academic standards to blacks. (They make a plausible case, but properly admit that no one yet knows precisely why this is happening.)

The Thernstroms puncture holes in every defense of racial preference in higher education. This is probably the best part of the book. Even if you tossed out the SAT and high school grades and focused only on extracurricular activities and socioeconomic factors, the numbers of blacks in elite institutions of higher education would be much lower than they are. This is not to say they would be shut out of colleges: The vast majority of colleges and universities have a noncompetitive admissions process; if you apply and have minimal qualifications, you get in.

For whatever reason, black high school students aren't being prepared well in high school for the few hundred competitive schools that do exist: They aren't taking college prep courses, they aren't keeping their grades up, and they aren't developing the other experiences or skills necessary to get in on their merits. This isn't just because of incomes; on the SAT, even poor whites on average score better than black students from relatively wealthy families. Rather than dealing with this difficult problem, university leaders are pretending it doesn't exist. They admit students who are demonstrably unprepared for their college coursework and either fail to graduate them or further lower academic standards so they can.

For the 1989-1990 college freshman class, 60 percent of black students failed to graduate within six years, compared to 40 percent of whites. When colleges attempt to display their social commitment by admitting high-risk students from minority groups, it is the students who suffer when the risks don't pan out. The schools may feel better for demonstrating enlightened racial attitudes, but many of the presumed beneficiaries end up worse off.

In many cases, colleges defend their policies by citing the need for diversity, as if this goal is more important than scholastic rigor. The nation's competitive colleges are, in effect, playing a crude racial counting game--either because of the ideological pretensions of their faculties and leaders or because they think they have no choice--and the Thernstroms heap deserved scorn on it.

While the Thernstroms are fastidious about documenting their arguments, there is one important area in which they are generally unconvincing. As a native Southerner who has had many a locker-room conversation, I don't share the Thern- stroms' trust of public opinion polls in identifying improvements in racial attitudes. Lots of white people retain prejudices, of varying degrees of magnitude and kind. Probably lots of black people do, too. They just don't share them with pollsters.

Still, what America in Black and White shows is that, to the extent a problem persists in social relations among whites, blacks, and other minorities, it is only exacerbated by race-conscious public policies such as preferential admissions and minority contracting goals. Modern liberals celebrate the statement of Justice Harry Blackmun, in the infamous Bakke case on college admissions, that "in order to get beyond racism, we must first take account of race"--even though it is self-evidently moronic. In public policy, getting beyond race means getting beyond race. Nothing less.

Health Nuts

info@reason.com (John Hood) — Mon, 01 Dec 1997 00:00:00 EST

As a newspaper columnist and a writer for national magazines, I have spent the past several years advocating medical savings accounts as one solution to the nation's health care problems. MSAs would allow individuals (and participating employers) to put tax-advantaged money into special accounts from which they could pay routine medical bills; major medical problems would be covered by high-deductible, low-premium catastrophic insurance plans. I've absorbed and employed all the standard arguments for MSAs--that the special tax treatment given employer-provided health insurance is distorting the market, that MSAs would increase consumer choice, that they would reduce administrative expenses and simplify medical purchases.

As it happens, I am also the president of the John Locke Foundation, a nonprofit think tank that provides health insurance coverage to nine employees with a wide range of ages and health conditions. If any small business could benefit from the MSA option, you would think it would be ours. But you would be wrong.

When last year's ghastly Kassebaum-Kennedy health insurance bill passed Congress, one item was worth cheering: a test of MSAs in the small-group market. Beginning January 1, 1997, self-employed persons and firms with 50 or fewer
employees could purchase MSA-based health insurance policies. These policies can have deductibles of up to $4,500 per family and allow both employers and employees to make deposits into MSAs, from which subscribers can draw to pay for routine medical care. Three-quarters of all money deposited into MSAs is tax-deductible, thus helping to equalize the tax treatment of wage compensation (such as cash or MSA deposits) and nonwage compensation (such as insurance premiums). This is not a "use it or lose it" program: Any balance remaining in an individual's account at the end of the year continues to accumulate.

The MSA program is a test, not a permanent change in policy. The test period is four years, and the number of individuals who can participate is limited to 750,000 nationally.

Depending on whom you listen to, the MSA test has been either a bonanza or a bust. Knowledgeable observers believe that some 100,000 people have chosen MSAs. While that's a lot of customers for a new product--a leading MSA advocate, Golden Rule Insurance, has itself enrolled nearly 30,000 people--it is only a hiccup in the context of millions of potential customers. No one really knows what the long-term trend in MSA enrollment will be, but it is fair to say that MSA advocates (including me) expected a lot more interest at the outset.

MSA opponents have seized on the underwhelming early results of the MSA test to proclaim the concept irrelevant at best. But based on my own experience as a would-be MSA customer, the problem lies not with the idea of MSAs but with the design of the test.

Earlier this year, I set out to look for MSAs for the Locke Foundation. I learned a lot. First of all, talking to insurance agents about MSA plans available in my area was like pulling teeth. Part of the problem is that most independent insurance agents who sell health coverage to firms like mine make their money by taking a commission on the first year of premiums. Since MSAs are combined with high-deductible insurance policies that have correspondingly lower premiums, agents who rely on such commissions aren't likely to be wild about MSAs. Of course, insurers could change their compensation structures to eliminate this disincentive, but that will probably take some time and experience.

Commissions are not the only financial disincentive. Acquiring the information required to sell MSAs is an expense that many agents have apparently not chosen to pay. I discovered that, while some agents may not have liked MSAs in the first place, many others were simply ignorant about them. I found myself explaining the benefits of MSAs to agents purportedly trying to sell them to me--not exactly a typical buyer-seller relationship.

In defense of insurance agents, however, the limitations placed on the MSA test are probably the main culprit. A product that can be sold only to a limited category and number of customers, and only during a test period, is a product unlikely to interest potential sellers with money to make elsewhere. Not surprisingly, while many large national insurers have come up with MSA products, few have designed serious training and marketing programs to make them competitive.

In my case, I finally found an agent who understood MSAs and could give me some real information about policies and prices. Then I really got a shock. The most competitive alternative would have cost us hundreds of dollars more a month than our current insurance plan, which combines traditional deductibles and copayments with a preferred provider network. The reason? Like many small firms in similar circumstances, we are enrolled in a purchasing alliance--in our case provided as a perk of membership in the local chamber of commerce--that allows us to receive price breaks through bulk buying.

The alliance we belong to is made up of about 370 firms and covers some 4,000 workers and dependents in the Southeast. Insurers bid to cover members of the alliance, and we have a choice of winning bidders. The prices we are able to command through this arrangement--which, I hasten to add, is purely voluntary and does not require Hillary Clinton's sanction or aid--are lower than the best price I could find for an MSA plan for our nine-person group. That disparity is part of the plan, it seems: The MSA test rules forbid the creation of analogous alliances.

Another surprise was how MSA plans have to be structured under federal law. Rather than having direct access to a savings account and thus being able to pay directly in cash for routine services, MSA administrators have complete control over disbursements. So even though you are using an MSA, you still have to file a claim with your insurer and wait a while for your reimbursement check. Maybe such a system is inevitable, given the need to guarantee that the tax deduction be taken only for medical expenses, but it certainly takes away a major selling point of MSAs to average consumers tired of playing the claim game with insurance companies.

Even with all the barriers that Kassebaum-Kennedy put in front of MSAs, they will still provide hundreds of thousands of Americans with a new way to purchase health care and save for the future. This is a real achievement, but in order for it to have a broad effect on the health care marketplace some changes are needed. Here are some ideas:

n Junk the time limit and the enrollment cap. The slow start we have seen in MSA enrollment is really an excellent argument for getting rid of the four-year limit and the 750,000 cap on subscribers. Congress should also repeal the enrollment cap of 390,000 on the Medicare MSAs included in the budget deal with President Clinton.
As I noted earlier, it is quite likely that many companies and agents have made the rational decision not to make costly investments in time and resources to market a product with a circumscribed customer base. While many people who follow health care policy closely understand the MSA concept (even if they don't like it), most people I know really don't get it at first. You have to take some time to explain carefully how it would work and how the tax benefits, in particular, may be significant even if they aren't immediately obvious. It is unfair to expect potential MSA vendors to develop cheap and effective ways to market this somewhat complicated product if enrollment is capped and time-limited.

Furthermore, MSA opponents have celebrated too soon about the relatively few people who have chosen MSAs so far. The small number actually weakens their argument for limiting the test. After all, if consumer interest is so tepid, what need is there to cap enrollment to protect existing insurance pools from the mass exodus of young, healthy people that MSA critics worry so much about?

n Allow large groups, including alliances of small firms, to choose tax-deductible MSAs. The logic of allowing only small firms and the self-employed to choose MSAs was never clear to me. Because large employers often have full-time employees devoted to studying benefits and getting the best deals, the subtle advantages of MSAs are more likely to be appreciated there than in small firms where managers (like me) have many other demands on their time. Even so, Congress would fix the problem many other small firms like mine are having by letting purchasing alliances include MSAs without penalty.

n Allow all firms, large and small, and individuals to set up "back-ended" MSAs. Like the so-called back-ended IRAs included in the federal budget deal, back-ended MSAs would scrap the tax-deduction for deposits into savings accounts but allow savings to accumulate tax free and be withdrawn later without tax penalty.

The only real difference from the current tax code would be that investment earnings in these MSAs wouldn't be taxed, so they won't save depositors nearly as much as the "front-ended" MSA would. On the other hand, maybe such a reduced tax benefit could be paired with direct access by depositors to their funds, so they would write checks or swipe debit cards from their MSA at the doctor's office rather than having to file claims and wait for reimbursements.

As my own experience has demonstrated, making MSAs truly a competitive product in the insurance market means more than inserting a limited test into a bill. It means making it clear to employers, workers, and insurers that MSAs are here to stay and available in some form to just about everybody. Any test short of that will be inherently rigged against success. Medical savings accounts, an idea with so much potential, deserve better.